Home Equity, Explained
Home equity, put simply, is the difference between what you owe on your property and the amount it would sell for.
How Equity Works
So how exactly can you calculate your home equity? Well, it's actually really simple: identify the current market value of your home and subtract out your loan balance, lien payoffs, etc. The amount you are left with (what you would net if the property was sold) is your equity.
As an example, let's say you purchased a home for $300,000 and made a standard 20% down payment ($60,000) leaving you on the hook for $240,000 in loans. In this case, you technically have 20% equity in the home, or $60,000 worth.
Building Equity
The more equity you have, the better — after all, it means you'll walk away with more if you were to sell your home! So how exactly do you gain equity? While there are a number of ways that it is ultimately possible to build equity, in most cases, it's accomplished by the following:
- By lowering the debt to market value ratio — usually by making payments on your mortgage.
- An increase in the market value of the property — typically a product of time or a change in the market but can also be achieved by making home improvements or upgrades.
Using Your Equity to Buy a New Home
Having equity in your current home gives you a major jump-start when it comes to purchasing a new home. When it's time to sell your home you will be able to use the equity built in your current home to put towards a down payment on your next one.
For instance, if your home is worth $250,000 and you have built $50,000 in equity, assuming you get asking price, you will make a profit from selling your home. While it would be amazing to have that entire $50,000 in your pocket you will have to factor out some fees such as closing costs and commissions. Even still, you have a great chunk of change left over to put towards your new home.
Borrowing Against Equity
In some situations it may work well for you to use the equity you have built-in your home as a line of credit. You may have heard this referred to as a second mortgage. As you would typically need to sell your home in order to access the equity, this option allows you to keep and live in your home while also gaining access to the equity.
Equity and Retirement
A home is a valuable asset to own, and if you're a homeowner who is older than 62 and owes less than 50% of your mortgage — you may be able to tap into that equity with a reverse mortgage. Yep, even if you still owe on your home, you can access your equity if you need cash.
A reverse mortgage is a type of loan that converts home equity into cash and allows a homeowner to borrow against the value of their home. So instead of making loan payments, you would receive money from the lender.
Reverse mortgages can be a great tool for retirement, but you will want to make sure you've thoroughly researched this option and found that it will be a good fit for your situation.
Building equity in your home can take some time and work, but the benefits are well worth it. Whether you plan to use equity to buy your forever dream home, borrow against it to pay off those pesky student loans, or to safeguard your retirement, there is no question that building equity opens many doors for your future.
